By: Leah Norod
“S-Corps” is a buzzword you may have heard tossed around while researching ways to structure your new business. Perhaps you heard it whispered in the street. Luckily there’s no secret entrance, and there’s a reason it’s talked about so often – S-Corporations let you avoid double taxation on your business. However, S-Corp status is not for everyone. It’s an exclusive club, and it has rules. Here are a few things to keep in mind if you’re considering joining.
Everyone likes a tax break, right? S-Corps allow you to “pass-through” corporate income and losses to your company’s shareholders without also being taxed at the corporate level. Of course, if you want to keep getting those tax benefits you need to stay on top of your filings. The IRS requires you to file Form 2553 within 75 days of incorporating to get S-Corp status. You also have to complete annual filings, but not quarterly ones as required for normal corporations.
Form 1120S is the income tax return form for S-Corps, and it must be filed within 2 ½ months of the end of your company’s tax year. Keep in mind that some states require additional forms – in New York, you must file Form CT-6 in addition to the federal filing. Also remember that some states, like New Hampshire and Texas, don’t recognize the S-Corp status at all (they can’t sit with us).
If you bring your friends to Club S-Corp, they have to be cool and follow the rules. Your S-Corp cannot have shareholders that are corporations, LLCs, partnerships or non-resident aliens. In other words, your shareholders must be real “people.” Also, your shareholders must be US citizens or permanent residents – more on this in a bit. Your S-Corp can have up to 100 shareholders, but no more than that. S-Corps may also only issue one class of stock. All outstanding shares of your business must carry identical rights and privileges. In other words, you may not issue preferred stock to anyone, including yourself. Lots of rules, but we’re not done.
- Residency requirement:
This is a big one. If you’re not a U.S. citizen, can you own or be part of an S-Corp? The answer is yes, but you must meet the “Substantial Presence Test.” To do so, you must be physically present in the US for at least 1) 31 days during the current year; and 2) 183 days total during the past 3 years (including this one). Keep in mind that you must include 1/3rd of the days you were here last year, and 1/6 of the days you were here the year before that in the calculation, which means you can’t frontload the days.
For example, say you were in the U.S. for 150 days each in 2014, 2015 and 2016. Count all 150 days in 2016, 50 days in 2015 (1/3 of 150) and 25 days in 2014 (1/6 of 150), and add them up. Since the total for the 3-year period is 225 days, you’d meet the 183 day requirement. If it sounds confusing, that’s because it is. But if you or any your shareholders fail to meet the residency requirement, your company may lose its S-Corp status.
The key to S-Corp success is to stay organized. If you join Club S-Corp, only to be kicked out later for not following the rules, you’ll lose those tax benefits. Plus, you’ll have to relinquish your membership card.
Contributors: Shamila Ahmed